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100 Yuan (Photo credit: DavidDennisPhotos.com)

As financings go, the $7.8 million of three-year bonds that Tri-Tech Holding, Inc. (NASDAQ CM: TRIT) issued last month will not set any records for size. The significance of the financing, however, lies in the fact that it foreshadows a promising new source of capital for China’s small and medium-sized private companies.

According to research done by Yijiang Wang, professor of economics and human resource management at Cheung Kong Graduate School of Business in Beijing, small and medium-sized enterprises (SMEs) account for 99 percent of the total number of firms in China; 60 percent of the country’s GDP; 70 percent of employment; 65 percent of the patents filed each year; 60 percent of exports and 50 percent of tax revenues. Despite this large contribution to the Chinese economy, though, SMEs only use 20 percent of China’s financial resources. Per yuan of investment, they are eight to 10 times more efficient than China’s large companies in creating jobs, and four to six times more efficient in generating GDP, according to Professor Wang. Obtaining access to capital to grow their businesses is one of the biggest problems faced by SMEs in China today.

With sales of $86 million and net income of $8.8 million in 2011, Tri-Tech is not a small company, but it certainly falls into the category of a medium-sized enterprise. Because the company is a leader in its field of water and waste-water treatment in China, it has enjoyed access to bank financing in the past, and has even been able to raise capital in the United States by selling its shares on NASDAQ. Struggling to finance a landmark $60 million waste water treatment project in the city of Ordos in Inner Mongolia that the company began in 2010 and expects to complete this year, however, obtaining sufficient capital to fund its growth has been an overriding issue.

Like all Chinese companies whose shares are traded in the United States, the price of Tri-Tech’s stock is suffering from the overhang caused by a number of well-publicized financial frauds by Chinese companies that have occurred over the past two years, and is selling at only three times earnings. Raising equity at that valuation is out of the question, and with conventional bank loans in China having a maximum term of one year, Tri-Tech turned to the bond market, a new source of capital in China, to obtain longer term financing.

Assisted by the Bank of Nanjing, which underwrote the bonds, Tri-Tech issued RMB 50 million (approximately $7.89 million) of three-year bonds to sophisticated investors, including financial institutions, on September 26. The bonds carry an interest rate of 6.2%, which will be paid annually, and principal on the bonds will be paid at maturity on September 26, 2015. In the meantime, the bonds will be traded on an inter-bank bond market.

While the issuance of bonds for a medium-sized company in China is news in and of itself, Tri-Tech’s bonds also have another feature that is worth noting — they are backed by a credit guarantee from Beijing Capital Investment & Guarantee Co. Ltd., a Beijing-based organization that guarantees the debts of SMEs. While credit guarantees have been in use in developed markets for a long time, they are relatively new in China.

In Tri-Tech’s press release on the subject, Peter Dong, the company’s CFO, commented as follows: “As one of the important diversification attempts to the company financing, this bond issuance will provide Tri-Tech with more capital flexibility to support our growth. Given the current valuation of Tri-Tech Holding in the capital market, we chose the corporate bonds instrument from the domestic market and believe this will efficiently fund our operations on a non-dilutive manner that is in the best interests of our shareholders.”

“The Bank of Nanjing conducted rigorous and comprehensive reviews of our company before agreeing to sign the Underwriting Agreement. We believe the bank’s and investors’ interest in these bonds reflects Tri-Tech’s healthy financial status, our comprehensive business records, our visible profit growth and our favorable credibility with the banks. We believe the guarantee from Capital Guarantee, additionally highlights our good reputation in the water industry.”

Obtaining access to capital is a challenge for SMEs in any country, but it has been especially challenging for those in China. The large state-owned banks have only been comfortable lending to other big state-owned and have been reluctant to provide loans to private SMEs. Recognizing that SMEs are the main drivers in any economy, though, China has begun to reform its banking sector, starting with the Wenzhou reforms announced in April, in order to provide them greater access to capital.

To the extent that bank reforms and other tools like bond financings and credit guarantees for SMEs are introduced into China’s capital markets, the transition of China’s economy away from government spending and toward consumption and the private sector that is already underway will accelerate. If good companies like Tri-Tech can get capital, they will lead the way in growth and innovation.